A Politicized World Demands Director Neutrality

Individual investors rely on corporate directors to protect their investments. Directors are watchdogs; they are minding the store on behalf of the public. The best directors have an interest in the specific company on which board they serve, are savvy about business and know their role as a director is to work on behalf of the company's investors.
 

Yet these days directors face distractions from an increasingly vocal, politically active institutional shareholder base. Rather than follow the stewardship model on behalf of individual investors, today's cohort of loud and angry institutional investors urges that directors meet novel eligibility criteria or promote specific political agendas. 
 

Politically active investors are increasingly urging boards to assume even more grandiose responsibilities — for example, promoting a “corporate culture of equity, diversity and inclusion” or “a business model wedded to principles of an environmental, social and governance agenda.”
  

Advocates appear unconcerned by how nebulous, vague, politically charged or divisive such directives can be. Moreover, while such efforts to promote diversity or responsible environmental reporting are laudable, directors also need to stay focused on their duty to shareholders.
  

Many investors have little understanding of what directors actually do — let alone what makes for a high-quality director. Directors have a fiduciary duty to the corporation and the shareholders. Such a responsibility should not be taken lightly.
   

That's why a few years ago I distilled 10 commandments for boards, according to Warren Buffett. Throughout his career, Buffett has served on two dozen boards on behalf of shareholders, commanding close to $1 trillion in equity.
   

Here is a simple statement of what the best directors aspire to — regardless of political agendas, gender, race, corporate culture or management principles. Wise leaders of companies, boards and funds should consider forwarding this to their boards of directors and shareholders to review.
  

Select an outstanding CEO. The board's most important job is recruiting, overseeing, and, when necessary, replacing the CEO. All other tasks are secondary because, if the board secures an outstanding CEO, it will face few of the problems directors are otherwise called upon to address.
 

Set CEO performance standards. All CEOs must be measured according to a set of performance standards. A board's outside directors must formulate these and regularly evaluate the CEO in light of them — without the CEO being present. Standards should be tailored to the particular business and corporate culture, but stress fundamental baselines such as returns on shareholder capital and steady progress in market value per share.
 

Adopt an owner orientation. All directors should act as if there is a single absentee owner and do everything reasonably possible to advance that owner's long-term interest. Directors must think independently to tighten the wiggle room that “long-term” gives to CEOs. While corporate leaders should think in terms of years –not quarters – they must not rationalize sustained subpar performance with perpetual pleas to shareholder patience. To that end, it is desirable for directors to buy and hold sizable stakes in their companies.
 

Replace managers promptly when needed. If senior managers' performance persistently falls short of the standards set by the outside directors, then the board must replace them, just as an intelligent owner would. In addition, the directors must be the stewards of owner capital to contain any managerial overreach that dips into shareholders' pockets. Pickpocketing may range from impulsive acquisition sprees to managerial enrichment through interested transactions or even myopia amidst internal scandal and related crises.
 

Speak up to colleagues. Directors who perceive a managerial or governance problem should alert other directors to the issue. If enough directors are persuaded, concerted action can be readily coordinated to resolve the problem before it gets worse.
  

Reach out to shareholders. When a director remains in the minority, and the problem is sufficiently grave, reaching out to shareholders is warranted. Colleagues may resist or complain, which imposes a useful restraint against going public for trivial or nonrational causes. But consistent with confidentiality and other fiduciary duties, informing shareholders is sometimes appropriate.
 

While politically active shareholders are flexing their muscles, corporate directors must remember that they are duty-bound to all shareholders. There is even a case that directors should pay particular attention to individual investors, who have no institutional voice or power at all, but whose life savings often depend on those directors.